The European Commission published its consultation (the "Consultation") on the review of the Markets in Financial Instruments Directive ("MiFID") in December 2010. The Consultation, which closed on 2 February 2011, sought views of market participants, regulators and other stakeholders on possible changes to MiFID's regulatory framework. The Commission Services envisage that the responses will provide "important guidance" in preparing a formal Commission proposal, currently scheduled for adoption in the second quarter of 2011.
In advance of the formal Commission proposal, this paper considers some of the issues raised by the Consultation's suggested changes to the regulation of investment advice1, and in particular the extent to which proposed amendments might conflict with FSA Rules made as part of its Retail Distribution Review ("RDR").
If implemented in full, the changes proposed by the Commission would increase the duties owed by firms to clients to whom investment advice is provided, notably in the post-trade context. There is little in the Consultation by way of justification for the change and no adequate cost-benefit analysis, although the formal Commission proposal is to be accompanied by an impact assessment.
Post-MiFID UK developments
Since the implementation of MiFID in 2007, the FSA has undertaken a number of domestic initiatives related to improving the quality of investment advice, including a review of the marketing and distribution of Lehman-backed structured products. The FSA's work in this area is continuing into 2011, with the publication of a Guidance Consultation on suitablity and the imposition of a £7.7 million fine in respect of suitability failures, the largest for retail failings to date.
Equally significantly, the FSA has remained committed to its work under the RDR which began in 2006 and is intended to address perceived structural shortcomings in the UK retail advisory market. Formulation of the new Rules relating to the RDR is now nearing completion, although they will not come into force until 1 January 2013. Of particular relevance in this context are the new Rules in the FSA's Conduct of Business Sourcebook on adviser charging and advice labelling (the "RDR COBS Rules"2).
The Commission proposals
- Independence of advice
Neither MiFID nor its implementing measures currently address the basis on which investment advisers are remunerated or how they describe their services. In the light of concerns expressed by "several regulators and market participants", apparently in respect of advice on unsuitable products or the impact of complex products on investors who did not fully appreciate the risks, the Commission is turning its attention to possible improvements in this area.
Specifically, the Consultation proposed3 that intermediaries would, under amendments to the MiFID Directives4, be obliged to inform an investor whether the advice they gave was based on an "independent and fair" analysis. Where this was the case, they would:
- be obliged to assess a sufficiently large number of financial instruments available on the market, notably, financial instruments of different types and from different providers; and
- be prohibited from accepting any payments or benefits from any product providers.
It is undoubtedly important that clients should fully understand the basis on which investment advice is being given, before it is provided, especially if the scope of the advice is to be limited in any way. However, these proposals raise a number of immediate issues from a UK perspective.
- Firstly, is it the Commission's intention that these provisions should apply only to intermediaries giving advice? It is difficult to see why the same standard should not apply to firms (for example, many private client wealth managers) who act as both product provider and adviser in relation to the same client.
- Secondly, what would a "sufficiently large number" of financial instruments be? Is it the Commission's intention that this should be a quantitative rather than a qualitative assessment, i.e. by reference to a particular percentage or other number, rather than a particular type of financial instrument? As many firms will be aware, the range of instruments with which a firm will need to be familiar is likely to be a key issue in deciding whether or not they decide to pursue "independent" status.
The RDR COBS Rules will require5 that an adviser does not hold itself out to a retail client as acting independently unless the only personal recommendations in relation to retail investment products it offers to that retail client are
- based on a comprehensive and fair analysis of the relevant market; and
- unbiased and unrestricted.
During the consultation process for this part of the RDR, there was naturally substantial debate over what the scope of a "relevant market" should be. As many readers will be aware, the FSA has elected to include Guidance on the meaning of this term in the final form of the RDR COBS Rules. This states that the relevant market should be treated as comprising "all retail investment products which are capable of meeting the investment needs and objectives of a retail client"6. The onus is on advisory firms to decide for themselves whether they meet the conditions attached to "independent" status. In practice, it seems that there are unlikely to be many situations in which an advisory firm will be able to hold itself out as acting independently where it does not survey the entirety of the market for retail investment products.
- Thirdly, is it the Commission's intention to apply these requirements to intermediaries when they give advice to professional clients?7 It is not clear that the proposal would apply only to advice provided to retail clients (as is the case with the RDR COBS Rules8), or be limited to advice relating to investments typically considered as retail investment products (as opposed to advice relating to any MiFID financial instrument)9.
- Fourthly, unlike the position under the RDR COBS Rules, the Consultation was silent on what advisers who do not provide independent advice would be required or allowed to call themselves.
- Fifthly, is it the Commission's intention to apply the ban on payments from product providers (which is intended to prevent them influencing advisory recommendations) only to intermediaries providing independent advice? This would be laxer than the position under the RDR COBS Rules, where an adviser will be subject to the new adviser charging requirements regardless of whether it provides independent or restricted advice10.
- Finally, there is no suggestion that product providers would be allowed to offer arrangements to have the adviser's fees or charges deducted from a client's investments, an arrangement that is explicitly allowed on certain conditions under the RDR COBS Rules.
It is worth noting that the Consultation addressed a separate section to the question of inducements, with further proposals relating to other advisory investment services, such as investment management. These will be considered in a separate briefing on inducements.
- Reporting on advice
The Commission considered it appropriate to introduce additional detailed requirements which would require firms providing investment advice to report to their clients in writing the underlying reasons for their recommendations, including an explanation of how they would meet a client's profile.
- Ongoing advice
The Consultation also proposed that investors could require a firm to provide ongoing services following an initial recommendation:
- the firm would report regularly and at least every six months on the market value (or the fair value when the market value is not available) and the performance of the financial instruments recommended. For complex products, the reporting would be quarterly, and the Consultation proposes in any event that a firm would be obliged to report when "material modifications in the situation of the financial instruments recommended to the client occur";
- the firm would also request the client, on an annual basis, to update the information concerning his personal circumstances. If the client refused to do so, the firm would be allowed to assume that the initial circumstances were still unchanged; and
- the firm would then confirm, at least on an annual basis that, based on the "evolution" of the financial instruments initially recommended and of the personal circumstances of the client, those instruments were still suitable to the client's personal situation, including in terms of risk diversification of his overall investments.
These proposals are consistent with others in the Consultation extending post-transaction obligations on firms, such as the proposal for firms holding client instruments to inform clients "in a timely manner" when "material modifications" in the situation of financial instruments occur. They raise questions which may ultimately affect the range and costs of services which firms may, in due course, wish to provide.
For example, it seems likely that a firm would want to consider, when deciding on the range of investments on which to offer advice, the feasibility and costs of providing these ongoing services. As mentioned above, the Consultation did not consider the costs of its proposals, which may be passed on in full to clients and may potentially be significant in some cases.
In turn, clients may or may not be keen to review and update, where necessary, the firm's original fact-find on an annual basis, in particular given that the firm will presumably wish to charge for the advice or "confirmation" supplied.
- Definition of investment advice
As expected, the Commission was supportive of an amendment being made to the MiFID Level 2 Implementing Directive to make it clear that investment advice can be provided through distribution channels (for example, the internet or mailshots). The current definition explicitly excludes recommendations issued exclusively in this way.
The impact of the initial Commission proposals discussed above will of course depend on the extent to which they are subject to amendment during the legislative process. However, their impact will also depend on the outcome of other aspects of the Consultation. Although consideration of these areas is beyond the scope of this paper, relevant proposals include those on inducements, a potential ban on execution-only business, the imposition of civil liability on firms for breaches of regulatory duties and a limitation or prohibition of the ability of Member States to impose local requirements above and beyond those set out in the MiFID Level 2 Implementing Directive.
Of these proposals, the last - the abolition of the right of Member States to impose local "gold plating" of the MiFID Level 2 Implementing Directive - is particularly significant to the FSA's work on the RDR, given that it has already notified various aspects of the RDR COBS Rules to the Commission as permitted "gold plating". Crucial will be the question of whether existing "gold plating" notified to the Commission would be allowed to remain in place in the event of this right being withdrawn.
Perhaps the greatest difficulty with the Consultation is that many of its sections are extremely short and lacking in detail. In many cases, there is little or no explanation or reasoning in support of the proposals, and so it is difficult to take issue with the underlying rationale or suggest alternative solutions. The proposals are notably lacking any cost benefit analysis. These factors make it difficult to judge the comparative significance attached to many of the proposals, and so their likelihood of survival into legislation.
While it is clear that the proposals have been influenced by the FSA's work on the RDR, it remains to be seen how much the Commission's proposals will ultimately impact the detail of the RDR COBS Rules, bearing in mind the very obvious potential points of difference that currently exist. It would be particularly unfortunate if the RDR COBS Rules had to be extensively revised so soon after their finalisation.